Monday, March 23, 2009

Bought GJR/ Walgreens/Did Right Brain Call the Bottom?

1. Details of Stocks Purchases by RB in Violation of the VIX Asset Allocation Model: Mr. Right Brain, sort of a per se animal spirit, started violating the trading rules with gusto on 3/6 with purchases of Disney, Ingersoll Rand, NYSE Euronext, Medtronic and Dupont

During the weeks of March 9th and 16th, Right Brain continued his frolic and detour by continuing the buying spree, based on something called intuition, a term as incomprehensible to Mr. Left Brain as the word "rule" is to Mr. Right Brain, and such purchases included Coca Cola, Campbell Soup, the ETF KXI, Heinz, Procter & Gamble, Unilever, Alcoa, Brookfield Asset Management, St Joe, EWC-the ETF for Canadian stocks, Conoco, a Bank of America trust preferred in the TC MJH, a Aegon preferred stock, a Lexington Realty equity preferred and a few others. Right Brain does not keep track of anything, could care less about rules, being a doer rather than a deep thinker like Mr. Left Brain.

In fact, the only securities bought out of about 25 or so purchases that actually complied with Left Brain's detailed trading rules were two TCs, JZV and DKF, that contained senior bonds from CNA and Goodrich respectively.

Time will tell whether Mr. Right Brain called the bottom, something that Left Brain can only think about.

This kind of synthetic security is a little complicated. The underlying bond is not a floater but a fixed rate bond. It is a PG note due in 2034 with a coupon of 5.8%. The floater is created by a swap agreement. If the swap agreement is cancelled, then the investor in GJR receives the interest rate provided in the underlying bond. This is a link to the prospectus:

If there is a swap termination event, then there is a reversion to the 5.8% fixed coupon as the yield for this TC. But at a $11 cost, the effective current yield would be 13.18% and I would be extremely pleased by that event.

What happens on an early termination of the swap event is explained in the summary at p. S-5. Assuming no swap termination, then the interest is a floating rate and a bad one, a factor reflected in the current price of this security. Interest is paid monthly based on a calculation of just .7% above the three month treasury bill rate which is fairly close to zero now. But I would still view this as a better buy than last Friday's purchase of GJO which floats 1/2% above 3 month LIBOR. Just for illustration, I will use two examples to compute my yield on this PG floater. First, using a 3 month T bill at a constant .3% (actually fluctuates at every weekly auction) and a $11 cost, the yield is 1% based on a $25 par value which translates to a different yield % with a purchase at $11 per share (25 cents paid per year for each share in interest divided by $11 cost= 2.27%, still pretty bad normally but a lot better than treasury bills) Second, using a 3 month T bill at 5% and a $11 cost (rounded for ease of calculations), the yield goes up to 11.3% and that is what is enticing when you believe, as I do, that inflation will naturally rise again from the actions being taken now. The TC has a maximum yield of 7.5% which means that the maximum yield at $11 will be 17.045%, calculated as follows: .075% x $25 par value=$1.875 divided by $11=17.045%. However, due to the float provision that adds .7% to the 3 month T Bill rate, the maximum yield would be reached when the 3 month treasury bill hits 6.8%.

Also, the TC and the underlying bond mature at the same time on August 15, 2034, which would result in a $1400 profit on 100 shares at that time assuming payment in full by P & G at that time. I will generally amortize that figure over the life of the bond to see how it juices my annualized return and will use 25 years for ease of computation to arrive at an approximate figure: $1400 divided by 25 years=$56 per year divided by $1100 cost=5.09%.

I would seriously doubt that this security would be priced at $11 except in the current environment of quantitative easing by the Federal Reserve causing the three month Treasury to fall to almost zero.

Thus, this purchase was purchased today mostly as a hedge against a return of inflation and an end to the current cycle of Fed easing. This fits within my asset allocation scheme and fills a niche in my bond portfolio. The same reasoning discussed in connection with the purchase of GJO last Friday is equally applicable to GJR. Over the life of the bond, I would expect several cycles where the interest rate on GJR based on my cost falls into the 5 to 10% range, some briefer periods where the yield will range in the 10 to 17% area based on my cost, and the next year or two most likely will be less than 5% and possibly one or more periods of less than 5% lasting a similar time prior to maturity in 2034, if the security is held for that long. But, if held to 2034 and averaging out the yield returns over the next twenty five years, I would expect a total average annual return to be close to 12% based on my cost, with 7% coming from the average of the current yields over the life of the security and the remaining 5% from the profit on the security.

This is just a wild, though plausible estimate, based on eyeballing historical 3 month T Bill yields since the 1950s and figuring my yield based on the float provision and my cost (actual monthly yields will be all over the place of course and could be higher or lower): www.federalreserve.

Only time will tell about any forecast about the future. The above linked chart is interesting to me since it shows how long the Fed engaged in quantitative easing during the Great Depression.

Both GJR and GJO are extremely unappealing to me at their current yields. The only way for the yield to improve is for short rates to rise significantly above current levels, which is not gong to occur soon I suspect. Moreover, if you have an extended period where short term rates are abnormally low, I would anticipate that all of these securities will be under downward pricing pressure. I would expect upward movement in share price from current levels,when and if the Fed abandons its current easing and starts a tightening cycle and assuming no credit issues for the underlying bond issuers. I would have to say that both of these purchases make sense only looking at the long term picture of interest rate cycles, the quality of the issuer and the deep discounts to par value, taken together, and then it is a close call as to when to do it.

3. Walgreens Earnings: Walgreens reported earnings for its 2nd quarter of fiscal 2009 at 65 cents which included a 6 cent charge for restructuring which saved the company 2 cents.

Comparable store sales increased just 1.3%. Gross profit margins decreased slightly by .6 to 28.3% as a percent of sales. Factoring out the extra items, earnings per share was flat with a year ago. Reuters

I have a small position of 50 shares.

DISCLAIMER:

I am not a financial advisor but an individual investor trying to navigate my way through a difficult market. I have never worked for a financial institution and never will. In these posts, I am acting as an unpaid financial journalist and an occasional political commentator. I am also aggregating financial news stories that I view as important and providing any reader of these posts, assuming there are more than a couple, with links to those articles, sort of a filtered, somewhat intelligent, free search engine. Any discussion made by me of particular securities is not a recommendation to buy or to sell. Trade at your own risk. Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons. The sale may before or after the post. Before buying or selling any stock, even one recommended by a trusted financial advisor, please research it and make up your own mind which is what I always try to do. Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news. In this post, and all others by me, I am merely describing my reasons for purchasing or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale. The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile. By way of example, it is unlikely that I will ever need the funds contained in my retirement accounts. Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments. Information contained in my posts has been obtained from sources believed to be reliable but cannot be guaranteed. These posts by me do not constitute investment advice, nor shall they be construed as a guarantee of future results, or as an offer of any transaction in securities. All content in these posts is provided for informational and entertainment purposes only, and it is a form of entertainment for me.

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About Me

I am no longer in a capital accumulation phase. My key investment objectives are capital preservation and income generation.
I started to buy stocks in the late 1960s.
I have a balanced worldwide portfolio with a considerable allocation to cash. Starting in December 2016, I started to reallocate out of cash and into high quality short and intermediate term bonds and FDIC insured CDs using a ladder strategy.
I have been paring my stock allocation, selling gradually into the robust stock market rally occurring since the U.S. election.
In this blog, I will be discussing only a sample of my recent stock trades. I will be discussing almost all of my bond and CD trades.

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Disclaimer

I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this blog, I am acting solely as a financial journalist focusing on my own investments. The information contained in this blog is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this blog is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. For purchases of bonds and preferred stocks, the prospectuses need to be reviewed until fully understood by the investor.